SECURE Act Impacts Non-Spouse Beneficiaries of Retirement Plans
With the enactment of the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019, Pub.L. No. 116-94, Div. O, 133 Stat. 3137, estate planners have had to reevaluate how to advise their clients with respect to their IRAs and other retirement plans. Most significantly, the SECURE Act has removed the ability of a non-spouse beneficiary to take distributions over his or her lifetime, otherwise known as the “stretch” IRA, limiting him or her to a ten-year withdrawal timeframe. In simple terms, with this change, IRA holders now need to consider the overall tax impact to their non-spouse beneficiary and whether the beneficiary has creditor or matrimonial issues. Such was the case in In re Marriage of Dahm-Schell, 2020 IL App (5th) 200099.
While Dahm-Schell involved pre-SECURE Act funds, the Fifth District took up the issue of whether inherited IRAs and the minimum mandatory distributions required to be taken by the respondent was considered income under the Illinois Marriage and Dissolution of Marriage Act (IMDMA), 750 ILCS 5/101, et seq., for purposes of calculating child support and maintenance. (NOTE: On March 24, 2021, a petition for leave to appeal to the Illinois Supreme Court was granted.) With the SECURE Act now in effect, the analysis and ruling stemming from this nonprobate case should cause estate planning and probate attorneys some pause, especially as they try to counsel clients on the best way to plan with their retirement assets. As the case will illustrate, leaving retirement assets such as IRAs in trust may continue to be prudent if protection from claims of spouses is desired. However, the SECURE Act has made planning with trusts less tax efficient than ever before and, therefore, less attractive to many clients.
The facts and procedural history of Dahm-Schell are as follows. The petitioner-wife filed for dissolution of marriage in August 2014. 2020 IL App (5th) 200099 at ¶3. While the dissolution of marriage petition was pending, the respondent-husband inherited approximately $615,000 from the death of his mother. Most of the inheritance was held in two IRAs. In 2016, the parties stipulated that the inheritance was the husband’s nonmarital property. The court determined that the husband’s gross monthly income for purposes of calculating child support and maintenance equaled $8,764.16 based on the husband’s gross monthly income of $8,301.83 from his employment and $462.33 monthly dividends from the inherited IRAs. Id. Both parties subsequently moved for reconsideration of the 2016 order. 2020 IL App (5th) 200099 at ¶4. The circuit court affirmed its prior ruling and ordered that the dividends from the inherited IRA be considered and added to the husband’s monthly income for purposes of calculating maintenance and support. Id.
While his motion for reconsideration was pending, the husband filed a petition to reduce the amount of monthly maintenance and child support paid to the wife. 2020 IL App (5th) 200099 at ¶5. The husband alleged that his monthly income from employment had been reduced and that two of the children who were minors when the original amount was calculated had reached the age of 18. Id. Specifically, the husband alleged that his gross monthly income from his employment was $7,800, with the following additional income: “(1) interest income of $1.67, (2) dividend income of $743.92, and (3) distributions and draws of $894.25 (from the inherited IRAs).” Id. Thus, $10,731 of the husband’s annual income resulted from distributions and withdrawals from the inherited IRAs. 2020 IL App (5th) 200099 at ¶6.
In arguing that the $10,731 should not be included in the calculation of monthly maintenance and child support, the husband testified that (1) the distributions were mandatory by federal law, (2) the distributions upon receipt were immediately transferred to a nonmarital account, (3) the husband had no choice but to take the distributions, and (4) the inheritance was nonmarital property that the court previously ruled that wife was not entitled to. 2020 IL App (5th) 200099 at ¶¶7 – 8. On February 18, 2020, the circuit court entered an order pursuant to Illinois Supreme Court Rule 308 certifying the issue of whether mandatory IRA distributions constituted “income” for purposes of calculating maintenance and child support. 2020 IL App (5th) 200099 at ¶10.
In taking up the certified question on appeal, the appellate court noted that the issue of whether IRA distributions constitute “income” as it relates to child support and maintenance is “unsettled in Illinois.” 2020 IL App (5th) 200099 at ¶13. However, the appellate court looked to four cases (In re Marriage of McGrath, 2012 IL 112792, 970 N.E.2d 12, 361 Ill.Dec. 12; In re Marriage of Lindman, 356 Ill.App.3d 462, 824 N.E.2d 1219, 291 Ill.Dec. 969 (2d Dist. 2005); In re Marriage of O’Daniel, 382 Ill.App.3d 845, 889 N.E.2d 254, 321 Ill.Dec. 350 (4th Dist. 2008); In re Marriage of Verhines, 2018 IL App (2d) 171034, 129 N.E.3d 181, 432 Ill.Dec. 293) to conclude that the husband’s distributions from the inherited IRAs must be included as income in the calculations for determining child support and maintenance because (1) the inherited IRAs were never counted as part of the husband’s income and therefore is not being “double counted” for purposes of child support and maintenance and (2) the fact that the husband is required to take mandatory distributions is of no concern because he is receiving a benefit from the distribution.
In reaching this holding, the appellate court focused on two key issues: (1) the definition of “income” under the Act; and (2) whether there were issues of “double counting” with respect to the money going in and coming out of the IRA for purposes of calculating child support and maintenance. The Act defines “gross income” as “all income from all sources.” 750 ILCS 5/504(b-3). Because no further definition of “income” is provided under the statute, the court turned to the plain meaning. 2020 IL App (5th) 200099 at ¶13. The appellate court found that income “includes gains and benefits that enhance a noncustodial parent’s wealth and facilitate that parent’s ability to support a child or children.” Id., quoting In re Marriage of Mayfield, 2013 IL 114655, ¶16, 989 N.E.2d 601, 371 Ill.Dec. 11.
In McGrath, supra, the Illinois Supreme Court held that money in a savings account withdrawn by the noncustodial parent as his or her sole “income” was not considered “income” for purposes of calculating monthly child support. 2012 IL 112792 at ¶14. The McGrath court reasoned that “[t]he money in the account already belongs to the account’s owner, and simply withdrawing it does not represent a gain or benefit to the owner.” [Emphasis added.] Id. In the instant case, the husband relied on the holding in McGrath to support his argument that the IRAs were like savings accounts in that the IRAs already belonged to him before the dissolution of marriage was final. Therefore, the IRAs should not constitute “income” under the Act. 2020 IL App (5th) 200099 at ¶16.
The appellate court disagreed. First, they took issue with the assertion that the IRAs “belonged” to the husband. 2020 IL App (5th) 200099 at ¶17. The wife’s previous stipulation to the IRAs being nonmartial assets did not bar their inclusion in the calculation of child support. The appellate court clarified that the question of whether the inheritance could count as income for purposes of maintenance and child support was a separate question from whether the IRAs were martial assets. Id. The appellate court reasoned that because there was never a ruling to this effect, the inheritance was not barred from being included in this calculation. Second, the distinction in McGrath with respect to the savings account was not based on the type of account but rather on the fact that the spouse’s withdrawal of the funds did not represent a “gain” or a “benefit” because the money in savings account was already counted as income at some previous point. 2020 IL App (5th) 200099 at ¶¶17 – 18. Therefore, the savings account was not being “double-counted” for purposes of calculating the spouse’s income.
The appellate court then turned to other cases involving IRA withdrawals, namely Lindman, O’Daniel, and Verhines, to further analyze the issue of double counting. In Lindman, supra, the Second District held that distributions from IRAs were considered income under the Act. While the issue of double counting was not raised on appeal in Lindman, the court advised that “[t]o avoid double counting [where money was initially counted as income, then subsequently placed in an IRA], the court may have to determine what percentage of the IRA money was considered in the year one net income calculation and discount the year five [when the distribution was made] net income calculation accordingly.” [Emphasis added.] 824 N.E.2d at 1226.
Subsequently, in O’Daniel, supra, the Fourth District disagreed with the holding in Lindman based on the perceived inadequacy of the Fourth District to consider that IRAs are “ordinarily self-funded by the individual possessing the retirement account.” 889 N.E.2d at 258. The O’Daniel court noted that “[e]xcept for the tax benefits . . . and penalties . . . , an IRA basically is no different than a savings account, although the risks may differ.” 889 N.E.2d at 258. “The only portion of the IRA that would constitute a gain for the individual would be the interest and/or appreciation earnings from the IRA.” Id. The O’Daniel court did not take up the issue of what percentage of the husband’s IRA would have constituted income for purposes of calculating child support.
Finally, in Verhines, the Second District explained that the Lindman and O’Daniel holdings were not in “absolute conflict.” 2018 IL App (2d) 171034 at ¶65. The Lindman court held that IRA distributions are income after “subtracting for ‘double counting.’ ” The O’Daniel court held that IRA withdrawals are not income, except for “the portion representing interest and appreciation.” Id. Therefore, both decisions allow for the possibility that a portion of the IRA withdrawals would constitute income.
Considering the decisions in McGrath, Lindman, O’Daniel, and Verhines, the Fifth District provided the following test for determining if an IRA distribution or withdrawal is income for purposes of child support or maintenance:
first determine the source of the money at issue and whether or not that money has been previously imputed against the individual receiving the distribution or withdrawal so as to avoid double counting. If the money that constitutes the IRA has already been imputed against the party receiving the distribution or withdrawal as “income” for child support and maintenance purposes, then as stated in O’Daniel,
. . . [t]he only portion of the IRA that would constitute a gain for the individual would be the interest and/or appreciation earnings from the IRA. 2020 IL App (5th) 200099 at ¶22, quoting O’Daniel, supra, 889 N.E.2d at 258.
Applying the test to the specific facts in Dahm-Schell, the Fifth District held that because the husband’s inheritance of $615,000 was never factored into any child support or maintenance calculation, the mandatory IRA distributions must be included as income for purposes of calculating child support and maintenance under the Act. Unlike McGrath, the husband’s inheritance was a gift that was never counted as income and was therefore not subject to “double counting.” 2020 IL App (5th) 200099 at ¶25. The appellate court was further unpersuaded by the fact that distributions were mandatory under federal law because there is a benefit being conferred on the husband by way of these distributions. Accordingly, the certified question on appeal was answered in the affirmative and remanded to the circuit court with directions for recalculating child support and maintenance.
Dahm-Schell is yet another reminder of why estate planners must give careful thought and consideration to how retirement assets are distributed at the death of a participant. Following the enactment of the SECURE Act, many of the conventional methods and guidance relied on for decades have been turned upside down. Especially for a client whose estate is comprised largely of retirement assets, it has never been more important to pay attention to how his or her retirement plan fits into the plan as a whole to avoid unintended beneficiaries and to reduce the exposure of the client’s intended beneficiaries to depletion of the assets under the new rules.
For more information about estate planning and probate, see ASSET PROTECTION PLANNING (IICLE®, 2018). Online Library subscribers can view it for free by clicking here. If you don’t currently subscribe to the Online Library, visit www.iicle.com/subscriptions.